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Hexo’s “Smoke-Free” Strategy Is Solid, but Shares Remain Overvalued

Hexo (NYSE:HEXO) stock has traded sideways this month. Shares rose from $3.98 on July 29 to as high as $4.95 on Aug. 13. But since mid-August, shares have fallen back, closing at $3.94 per share on Aug. 29. Compared to its larger peers, shares have held steady.

Molson Coors May Be the Only Thing Propping up HEXO Stock

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Shares in Canopy Growth (NYSE:CGC) are down more than 28% for the month. Aurora Cannabis (NYSE:ACB) stock has fallen roughly 12.7% since late July. Hexo is becoming increasingly focused on “smoke free” uses (beverages, edibles, etc.) than its peers. Focusing on this niche could be its key to success.

TAP Partnership Provides Scale with Minimal Dilution

As I discussed in my prior article, expectations for cannabis-infused products drive the Hexo stock price. The company has partnered with Molson Coors (NYSE:TAP) to launch Truss. Truss is Hexo’s line of non-alcoholic, cannabis-infused beverages. This strategic partnership gives the company a greater chance of success in this space. With Molson Coors’s scale and infrastructure, Truss can be rolled out more efficiently.

Another positive of this partnership is the structure. So far, strategic partnership deals have been highly dilutive to cannabis company investors. With Canopy Growth, Constellation Brands (NYSE:STZ) has quietly taken over the company. This also happened with Cronos (NASDAQ:CRON) and its partner Altria (NYSE:MO).

Molson Coors received warrants as part of the deal, but the partnership is structured as a joint venture. Molson Coors owns 57.5%, with Hexo owning the remainder. This may limit upside if infused beverages are a success. But it limits Molson Coors’s control over the entire company. Molson Coors’s warrants only give it the right to buy 11.5 million shares at a strike price of $6 a share. With 256.9 million shares outstanding, and 50.9 million warrants outstanding, this hardly gives Molson Coors control over Hexo’s destiny.

Other catalysts could move the Hexo stock price. The company’s strategy focuses on “smoke-free” cannabis products. This includes edibles, vapes, wellness products, and cosmetics. Selling plain old pot is a commodity business. The opportunity to develop high-margin brands is the key to long-term profitability.

Hexo is no slouch when it comes to selling pot. The company remains Quebec’s biggest supplier. The recent acquisition of Newstrike Brands helps scale up their cultivation infrastructure. But is all of this reflected in the Hexo stock price? Let’s take a look at how the stock’s valuation stacks up to peers.

Hexo’s Valuation in Line With Peers

Using the Enterprise Value/Sales (EV/Sales) ratio, the company trades in line with peers. The company’s current EV/Sales ratio is 36.4. Compare this to Aurora Cannabis (EV/Sales of 45.6), Canopy Growth (EV/Sales of 35.3), and Cronos (EV/Sales of 98.5). An EV/Sales ratio of over 30 is still a rich valuation.

The expectations of Truss and other products inflates the Hexo stock price. Investor enthusiasm has tapered off, as seen from the 53% drop from its all-time high in April. If Truss is a success, Hexo stock should see a massive boost. But with the current rich valuation, additional declines are a risk. If investors lose faith in Hexo shares could fall much further.

So what does this mean for investors entering the stock today? Cannabis shares have been beaten down. But marijuana stocks have yet to trade at fire sale prices. It’s impossible to predict the unpredictable. Only time will tell if we have reached a bottom in cannabis stock valuation. But long term, investors may be getting a bargain entering Hexo stock at the current trading price.

Hexo Has Potential, but Tread Carefully

Hexo stock offers a unique opportunity for cannabis investors. While its competitors try to dominate the smoked marijuana space, Hexo is going “smoke-free.” Focusing on beverages, edibles, and other cannabis-infused products, the company could find riches in niches. Their partnership with Molson Coors is a conservative way to get scale without sacrificing much equity. Unlike its larger peers, Molson Coors is in no position to quietly take over the company.

The Hexo stock price remains inflated. Investors are betting on the company’s future potential. Long-term, shares could see big gains. Short-term volatility is a risk. Keep HEXO on your radar, but tread carefully before entering a position.

As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.